Financing

Soaring costs take a big bite out of Burger King franchisee Carrols’ already thin margins

The 1,000-unit franchisee’s adjusted EBITDA margin was more than cut in half last quarter thanks to labor and beef cost inflation. It is reducing its 10-piece chicken nuggets to eight.
Burger King Carrols sales
Photograph: Shutterstock

Imagine how bad things would be if Carrols Restaurant Group didn’t outperform the Burger King system by 600 basis points last quarter.

The burger chain’s largest franchisee, which operates about 1,000 locations—or roughly one out of seven locations in the system—took a massive hit in the fourth quarter. Adjusted EBITDA, or earnings before interest, taxes, depreciation and amortization that’s been adjusted for one-time events, declined to $13.9 million from $31.8 million in the same period a year earlier.

As a percentage of sales, the company said, its adjusted EBITDA margin was just 3.3%—a decline of 430 basis points. For the full year, the company’s margin was just under 5%.

And this is off relative decent sales. Same-store sales at its Burger King restaurants rose 7.4% in the quarter. The full system was up just 1.8%.

“There’s no question that our current cost challenges are among the toughest, if not the toughest, I have seen in all my decades as a restaurant operator,” CEO Dan Accordino told analysts on Thursday, according to a transcript on the financial services site Sentieo. Accordino is retiring in April after a 50-year career.

Restaurants have been combatting dual headwinds of rising wage rates and soaring commodity costs. They’ve been raising prices more aggressively—fast-food restaurant menu prices are up 8% year-over-year, according to federal data. But “maintaining margins” has been one of the industry’s biggest challenges, and many are struggling to accomplish that.  

This period has been particularly difficult for franchisees like Carrols, which pay a percentage of their revenue to their franchisor and make their money purely off operating profits. And the omicron variant, which led many people to call in sick, exacerbated all of these issues in recent weeks. But demand for restaurants did not ease.

Burger King has been working with its franchisees to improve profitability. The company has removed some items from its menu. It also lifted pricing caps off some menu items and removed the Whopper from its 2-for-$6 value offer. All of these efforts should help.

But the company is reducing the number of chicken nuggets in value meal offers from 10 pieces to eight, Accordino said, based on recommendations from the franchisor. That is coming as other chains cut down on portions in value meals, notably Domino's, which is reducing the number of chicken wings available in its $7.99 carryout offer.

Still, it’s worth looking at Carrols to get an idea of just how difficult the environment is for operators right now.

The biggest problem is labor. Burger King has been working to keep restaurants open from 6 a.m. until 11 p.m. and lost about 1% of its operating hours because of a lack of labor. Yet those efforts were costly. The company’s wage rates rose 14% compared to the prior year, before overtime. Accordino said the company believes labor rates will continue rising throughout the year.

Staffing issues, and a trio of snowstorms in the company’s biggest markets, have been hard on the company’s sales in January. Same-store sales were up 4.1% that month. But Accordino said the company lost about 4% of sales due to unplanned closures.

Another problem is food costs. The company’s commodity inflation rose 16% last quarter from the same period a year ago. Its big problem was beef costs, which rose 33% year-over-year. The reason, as it is for just about all restaurants, is the labor problems that are hitting many of the industry’s suppliers and distributors.

Like many other operators, Carrols is raising prices and reducing discounts. The company’s average check grew 12.1% in the fourth quarter. One reason is the influence of delivery—its average check for delivery orders was $17.58, compared with $9.57 overall.

But the company raised prices 8%. And reduced discounts also led to an increase in average check. “We’re in a mode, and the industry is in a mode, where we think we can take price without affecting traffic that dramatically,” CFO Anthony Hull said.

There is some good news, however. The company is seeing improvement in breakfast, a key part of Burger King’s overall sales improvement strategy going forward. Evening and late-night business has also improved. The company does expect labor and commodity costs to moderate in the second half of the year.

And the company believes acute, COVID-related staffing challenges have abated. “The first several weeks of February have been encouraging,” Accordino said.

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